Unlocking Hidden Potential: The Crucial Role of Business Valuation Beyond Sale Considerations

Introduction:
In the dynamic landscape of entrepreneurship, business valuation is often associated with the process of selling a business. However, its significance extends far beyond the realms of potential transactions. Entrepreneurs and business owners can reap a multitude of benefits by understanding the importance of getting a business valuation, even if selling the business is not on the immediate horizon.

1. Strategic Decision-Making:
   A comprehensive business valuation provides a detailed assessment of the company's assets, liabilities, and overall financial health. Armed with this knowledge, business owners can make informed strategic decisions. Whether it's expanding operations, acquiring new assets, or restructuring debt, a valuation acts as a strategic compass, guiding decision-makers toward choices that align with the company's financial reality.

2. Financial Planning and Management:
   Business valuations offer a snapshot of the company's current financial standing, enabling owners to develop effective financial plans. This includes budgeting, resource allocation, and setting realistic financial goals. By understanding the value of the business, owners can optimize their financial management practices, ensuring long-term stability and growth.

3. Shareholder and Partnership Matters:
   For businesses with multiple stakeholders, a valuation is crucial in managing shareholder expectations and resolving partnership issues. It establishes a fair market value, facilitating discussions about equity distribution, buy-sell agreements, and succession planning. This transparency fosters a healthy business environment and prevents potential disputes.

4. Attracting Investment and Financing:
   When seeking external funding or loans, a credible business valuation can significantly enhance the business's credibility in the eyes of investors and lenders. It provides them with a clear understanding of the company's worth and risk profile, making it more appealing for potential investment or financial support.

5. Insurance and Risk Management:
   Knowing the accurate value of a business is essential for insurance purposes. It ensures that the business is adequately insured against potential risks, such as property damage, liability claims, or unforeseen events. Accurate valuations help determine the appropriate level of coverage, preventing underinsurance or overpayment for unnecessary coverage.

6. Tax Planning and Compliance:
   Business valuations play a vital role in tax planning and compliance. Understanding the value of assets and liabilities assists in optimizing tax strategies, taking advantage of applicable deductions, and ensuring compliance with tax regulations. It minimizes the risk of overpayment and helps in maximizing tax efficiency.

Conclusion:
In conclusion, the importance of getting a business valuation extends far beyond the prospect of selling the business. It serves as a powerful tool for strategic decision-making, financial planning, and fostering transparent and healthy business relationships. By regularly assessing the company's value, business owners can navigate challenges, seize opportunities, and unlock the hidden potential within their operations.

During my travels this week, I heard about ESOPs a couple times. The first was at the Schaumburg Business Association Leadership Lunch where John Costello shared his journey as a business owner of Cherry's Industrial. He went from sleepless nights and the weight of the world on his shoulders to a thriving company with financial transparency, employees that share and live out core values, a common destiny and a shake in the outcome of the company.

I then read the Sunday Daily Herald Business section. This got a little more in the mud on the good and bad of Employee Ownership. ESOP plans are growing in popularity as a great way for a business owner to exit (dailyherald.com)

An ESOP can take various forms, but generally setting one up involves creating a separate entity that's owned by a company's employees, with the ownership determined based on a variety of factors from compensation to tenure to job position. They can be complicated, but below outlines some steps.

​To form an Employee Stock Ownership Plan (ESOP) for a company, follow these steps:

1. Design: Determine the objectives and structure of the ESOP. Decide what percentage of the company's shares will be allocated to the plan and how those shares will be distributed among employees.
2. Consult Professionals: Seek guidance from professionals such as lawyers, accountants, and financial advisors experienced in ESOP formation. They can assist with legal and regulatory compliance, valuation, and plan design.
3. Valuation: Conduct a valuation of the company to determine the fair market value of its shares. This valuation is crucial for setting the price at which the ESOP will purchase the shares.
4. Trust Formation: Establish an ESOP trust, typically in the form of a trust agreement, which acts as the legal entity to hold and administer the shares on behalf of the employees.
5. Financing: Determine how the ESOP will finance the purchase of shares. This can be through cash contributions from the company or borrowing funds externally.
6. Plan Documentation: Develop a comprehensive plan document that outlines the rules and provisions of the ESOP, including eligibility criteria, vesting schedules, and distribution rules. Ensure compliance with relevant laws and regulations.
7. Employee Communication: Communicate the ESOP's purpose, benefits, and mechanics to employees, emphasizing how it aligns their interests with the company's success.
8. Purchase of Shares: The ESOP trust purchases the company's shares using the funds allocated for this purpose. This can be done directly from existing shareholders or by issuing new shares.
9. Ongoing Administration: Establish procedures to manage the ESOP, including record-keeping, annual valuations, and compliance with reporting and disclosure requirements. Consider appointing a trustee or forming a committee to oversee the plan.
10. Employee Participation: Allocate the shares among eligible employees according to the plan's distribution rules. Monitor and update employee accounts as per the vesting schedule and any additional contributions made to the ESOP.
11. Repurchase Obligations: If employees leave the company or retire, establish a mechanism for the ESOP to repurchase their shares at fair market value, providing liquidity to exiting participants.

It is important to note that forming an ESOP involves legal, financial, and regulatory complexities. Engaging professionals with expertise in ESOPs is crucial to ensure compliance and a smooth implementation process.

Typical Situation: Our client is talking about their partnership and succession planning. Maybe another business owner they know died or became disabled and their company is floundering because of it. They are trying to figure out how to figure out how to disperse an estate equitably when not all the children are involved in the business. Their company has grown since they originally drafted their buy sell agreement and want a review.
 
When you hear a business owner say:

• “My taxes are too high.”
• “I would hate to have to deal with my business partner’s spouse.
• (What happens if my partner dies or becomes disabled?)”
• “What’s stopping my key employee from starting a business across the street?”

 
An Insurance Benefits Advisor protects business owners, their families and their businesses from the financial catastrophe that death or disability can cause. Whether it happens to a business partner, a key employee or themselves I make sure the financial impact is as minimal as possible.
 
How they Work First, they will do a deep dig to find out what the concerns are and other possible trouble points. Next, they educate on the possible solutions. Then once the client has the information needed to make a decision they implement the solution from one of our many carriers. They provide peace of mind and tax-savings ideas to business owners and successful individuals through qualified plans, life, annuities, disability, health, Medicare and long term care insurance.
 
Matching Ideas with Resources:

We have people that can help you. Please contact:
Tom Gosche, Business Strategist
​630-675-8971  [email protected] 

​Even if you are not currently thinking of selling your business, you should make every effort to prepare or ‘groom’ your business so it is sold successfully at the first opportunity. While the financial advisors you appoint will work with you to address issues specific to your company, there are a number of general grooming points worth considering (even before you appoint advisors) to maximize the value of your business:

Sales & Profitability: Historically, you may have been setting your prices, and thus your profit margins, at levels designed to create barriers to entry for your competition. If you are planning for a business sale your focus is likely to be short term strategies. It will be time to re-examine your market and customer base to see if higher sales and turnover levels are achievable. If the proposed sale itself is a number of years away, you should consider performing a strategic review of the entire business.

Operating Costs: You should regularly review your operating expenses but this is especially so when preparing your business for sale. You need to identify avenues to reduce expenses without affecting the operational effectiveness of your business.

Profit Trends: Apart from current margins, a purchaser will be looking at profit trends. Buyers are looking to see stable and steady yearly profit trends. Therefore, risky projects should be avoided and longer-term contracts that may prove to be onerous should be fully considered before acceptance. Unprofitable contracts need to be reevaluated and, if appropriate, terminated, as it is quite possible they will be detrimental to the value of your business.

Management Team: The purchaser of your business will be looking to acquire a high caliber management team. It may be worth reviewing your corporate structure to ensure that job titles and role descriptions adequately reflect the contribution that your management team makes to your business. Any re-structure needs finalization well in advance of an anticipated sale. A purchaser may also want assurance that the management team is supportive of your decision to sell or at least that it is likely to stay with the business for a reasonable period post-transaction. You should consider talking to management - how cooperative will they be? You never know, they may be interested in buying the business themselves.

Asset Base: Are there any assets in the business that may be of little or no interest to potential purchasers- e.g. short-term investments, under-utilized property, equipment or perhaps surplus cash? Think about realizing and removing them from the business before the sale. It is also worthwhile having all your property assets valued individually.

Restructuring: If your business has more than one division, some thought should be given to restructuring it into a number of stand-alone entities and perhaps selling these separately. Any such reorganization will have potential tax implications and other complexities associated with it and it will be important to take professional advice before undertaking any such initiative.

Tax Planning: Details of the various tax factors that you need to consider are set out in section 4 of this guide. Initial points to address include making sure that all your Corporation Tax, PAYE and VAT returns and payments are up to date. In addition, any tax losses that your company may have built up over the years may now have a value to the extent that they are available for use by the potential purchaser. Personal tax planning opportunities should be discussed with your tax adviser.

Valuation Expectations: You must have realistic valuation expectations. Valuation is important but do not let it get in the way of securing the sale.
​
Timing: Deciding the best time to sell your business can be a difficult decision to make. Factors to be considered when making this decision include the level of corporate activity in your industry; the state of the economy; changes in sector relevant legislation; and available tax reliefs (e.g. do you have to be a certain age to avail of certain retirement reliefs or pension planning opportunities).

These are all thinks that can help you, not only get your business sold for a great price, but help you grow your business beyond anything you ever dreamed of. I recommend you talk with an expert that has helped many business owners increase the value of their business:

SCOTT HANSEN
http://www.scotthansenconsulting.com

There are more buyers out there for your company than you might think. Ranking potential buyers from most to least logical requires an assessment of how each of the following characteristics applies to a particular buyer:

·         Potential synergistic benefits of your business if they currently own a related business
·         Capital / financing available to close the transaction
·         Experience in completing acquisitions
·         Previous knowledge of, or involvement with, the company / industry
·         Geographical proximity

It is at this point that it is time to make the first critical decision. How broadly should you market your company? A wide offering distribution increases the probability of achieving the best price, but also increases the likelihood of damaging your company by releasing sensitive business information to a wide range of people.

Your competitors may be the ‘best’ buyers, but they are also the ones who could inflict the most harm on your business if they are privy to confidential information.

From the perspective of the owner, prospective buyers, the IRS, lenders and divorce & bankruptcy courts, the value of a business for purposes of a sale, estate planning, orderly or forced liquidation, gifting, divorce, etc. can be vastly different.

Intrinsically tied to the various purposes of valuation are numerous definitions of “value.” Here are a few examples: 

• Investment Value – The value an acquirer places on a business based on a future return on investment determined by assessing past and current performance, future prospects, and other opportunities and risk factors involving the business.
• Liquidation Value – The value derived from the sale of the assets of a business that is closed or expected to be closed following the sale.
• Book Value – Book value is the difference between the total assets and total liabilities as accounted for on the company’s balance sheet.
• Going Concern Value – Used to define the intangible value which may exist as a result of a business having such attributes as an established, trained and knowledgeable workforce, a loyal customer base, in-place operating systems, etc.
• Fair Market Value – For the purpose of this article, the focus will be on transaction related valuations. Fair Market Value (“FMV”) is the most relevant definition of “value” and is of the most interest to business owners. The more knowledge business owners and prospective buyers have about the valuation process, the more likely they will come to an agreement on a purchase price.​

Congratulations, Now that you sold your business, there are reports you need to fill out for the IRS. 

Form 8594 is used to report the sale and purchase of a group of assets that constitute a business. Both the purchaser and seller must file Form 8594 with their own individual income tax return.
On Form 8594, the total selling price of the business is allocated to asset classes using the residual method.
Form 8594 provides the IRS with the following information:

• The purchaser's depreciable basis in the assets transferred, and
• How the seller determined gain or loss.

Assets Classes on Form 8594
Form 8594 lists seven classes of assets. For asset acquisitions occurring after March 15, 2001, make the allocation among the following assets in proportion to (but not more than) their fair market value on the purchase date in the following order:

Class I assets:

• Cash and general deposit accounts (including savings and checking accounts).
• Does not include certificates of deposits held in banks, savings and loan associations, or other depository institutions.

Class II assets:

• Certificates of deposit
• U.S. government securities
• Foreign currency
• Publicly traded personal property, including stocks and securities.

Class III assets:

• Accounts receivable
• Other debt instruments
• Assets that you mark to market at least annually for federal income tax purposes.

Class IV assets:

• Property of a kind that would properly be included in inventory if on hand at the end of the tax year or
• Property held by the taxpayer primarily for sale to customers in the ordinary course of business.

 Class V assets:

• All other assets other than Class I, II, III, IV, VI, and VII assets.
• Example of assets included in this class:
• Furniture and fixtures, equipment, buildings, land, and vehicles.

Class VI assets:

• Section 197 intangibles (other than goodwill and going concern value).
• Examples include, workforce in place, customer lists, clients lists, patient lists, trademarks, trade names.
• See the list of section 197 intangibles.

Class VII:
Goodwill:

• Goodwill generally represents the excess of the price paid for a business over its net asset value (also called book value). It may have the following characteristics:
• It may be associated with a company's good reputation in terms of the products it sells, the services it performs, and it's standing in the community. Other characteristics of goodwill include:
• It may be tied to the ability of a business to continue doing business with its existing customers and to attract future customers.
• It is an intangible asset that may only be acquired as part of the acquisition of a business.
• It is a section 197 intangible whose value is amortized over 15 years by the purchaser of a business.

Going concern value:

• Going-concern value is the value attributed to a business entity as an on-going enterprise.
• Going-concern value focuses mainly on the ability of the company's assets to generate a return on investment not simply goodwill.

If an asset described in (I) through (VI) is included in more than one category, include it in the lower number category. For example, if an asset is described in both (4) and (6), include it in (4).

6. Going Alone Syndrome
Below is a summary of some of the potential hazards of handling the sale of your own business:

• Limiting the buyer universe: An owner will tend to focus on only one or two possible types of buyers, usually direct competitors or customers. Unfortunately, such an approach could very likely leave out many potential buyers not readily known by management.
• Creating bad blood: Negotiations can be a very turbulent process, causing bad feelings and bruised egos. An advisor is able to act as a buffer between the buyer and seller, playing the ‘bad guy’ or being the scapegoat, if necessary.
• Being caught off-guard: By limiting the direct contact between you and the buyer, an advisor can protect you from the pressure to respond without proper consideration. Additionally, an advisor can offer a compromise during negotiations without being committed to it, to gauge the buyer’s reaction. By negotiating directly, you would forego this advantage.
• Lacking credibility: The involvement of a business broker in managing a professional sale process sends a clear message to potential buyers that there will be competition; that delay, or similar tactics will be ineffective; and that pertinent information will be carefully prepared and presented.

7. Favoring The Fast Track
Letting one attractive buyer get on the ‘fast track’, far ahead of the buyer pack, will cause you to lose your greatest weapon: competition from other bidders. The key is to build competition, to force buyers along your schedule and not theirs. A good advisor will know when the time is right to sit down and hammer out a deal with the buyer.

8. Sparing The Bad News
No one likes to be the bearer of bad news – particularly when the news contains potentially damaging information about a company that is for sale, or reports about the company’s key players. Unfortunately, the later bad news becomes public, the greater the threat of derailing the entire deal. By addressing bad news up front, you can establish a strong case and avoid potentially damaging innuendo. Negative reports can certainly influence overall valuation, but cover-ups or omissions, which will undoubtedly be discovered during buyer due diligence, could easily result in a broken deal that no price adjustment can repair.

9. Information Leaks
More than likely, you are not going to be able to keep the fact that you are selling the business a secret. It is best to avoid conflicts and protect your credibility by being direct with employees and key customers about the news, on your own terms.
​
10. Rushing To Market
If you are looking to maximize your company’s value, overcome the disruptive effects of a sale, and cash-in when it is all over, don’t expect it to happen as an overnight event. In addition, strong financial reporting systems and historical statements (preferably audited) are essential. They must support the financial data presented to potential buyers, and ensure that all the required documentation is available when it is required.
 
In Summary, selling your business is a difficult, complex and stressful process and not something you should undertake lightly. You should make every effort to prepare your business to ensure it is sold successfully the first time. Preparation and planning are the critical success factors in all business sales.

While this list is not exhaustive, just remembering these ten pitfalls will move you a long way toward achieving a successful transfer of ownership.

1. Not Minding The Store
More often than not in a sale scenario, the owner becomes preoccupied with the sale process and loses sight of the critical, day-to- day management issues. A sale can take anywhere from two months to two years. Hence, distraction from your business can be fatal to a deal - particularly during the latter stages. Late in the negotiation process, a buyer’s adverse reaction to negative reports of even a relatively minor problem could undermine the entire transaction.

2. The Unfocused Effort
Significant unfocused problems are more likely to arise the longer a transaction takes to be completed. The sale process will usually take some unexpected twists and turns, but for most situations, a good team of advisors and management will have contingency plans. The key is to be well prepared, confident and decisive, and to have clearly defined objectives.

3. Standing Up On The Roller Coaster
Selling your company can be one of life’s most stressful experiences. Besides dealing with the prospect of retirement, and with separation from a much-cared-for business, you must also face the inevitable scrutiny that your company and business activities will receive from every potential buyer. The key here is to keep your emotions in check. Being over-emotional is likely to lead to rash decisions, based on the heat of the moment, rather than on a rational agreement process.

4. ‘But-Your-Man-Got-More’ Syndrome
What another entrepreneur got for his company three years earlier, or what one large company paid for another, is irrelevant to your transaction. The market will dictate what your company is worth today. Ensure that your advisors do their homework to arrive at a preliminary valuation range, and then let the market do its work. Unrealistic price expectations are the quickest way to dampen buyer enthusiasm and ensure your disappointment. Inflated valuation expectations will impede you from recognizing reasonable bids.

5. Going With The Highest Bidder
When it comes to ownership transfer, the highest price bid may not be the best deal for you. A number of critical issues could override a decisive price difference among competing bids:

• Financial ability of the bidder to close the deal.
• Contingent liabilities that you must accept for some period after the sale, such as those related to environmental problems, pending litigation and the salability of stocks.
• Contingencies or ‘outs’ in the buyer’s offer, such as due diligence, environmental audits, financing, board or parent company approvals.
• Employment agreements for the seller and key employees, including length and level of compensation.
• Form and timing of consideration to be paid if other than cash, such as loan notes, shares and earn-out.

​Stay tuned for the rest next week!